S&P’s Case-Shiller home price index of 20 major metropolitan real estate markets for July is out today, and the good news is both broad and deep. Prices were up 5.9% for the first seven months of the year, their largest year-to-date gain in seven years, and significantly better than increases in 2011 (0.4%) and 2010 (2.1%). Prices rose in 16 of 20 markets compared with a year ago, and while they’re still 30% off their 2006 peak, it’s important to remember how inflated those 2006 prices were.

Even better is the depth of the improvement, as prices increased even in the cheapest homes. The gap between price gains in the high end of the market and the low end has narrowed, and the bulk of the gains come from the bottom and middle tiers. Even though four of the 20 Case-Shiller markets aren’t showing the gains, and Atlanta in particular is lagging, the trend is undeniably positive. Reinforcing it are data that show single-family housing starts well ahead of last year’s pace, existing home sales are up, the inventory of homes for sale is down, and foreclosure activity is slowing.

Rising home prices increase the net worth of home owners. And, as a result, the improved balance sheet has a psychological impact, causing people to feel better about their situation, and this reduces frugality. If their home price increase allows them to refinance at lower rates, the impact is multiplied.

There’s more. The Conference Board recently reported that its consumer confidence index rose in September to its highest level since February. Remember that consumer purchasing drives 70% of the American economy and it dovetails nicely with renewed optimism; the number was well above August’s level and also well above economists’ expectations.

Are we finally seeing the beginnings of a self-sustaining recovery, where the trends reinforce one another and a pattern of economic growth becomes clear? It’s still too early to tell, but it’s not too early to be cautiously optimistic. Growth won’t be a straight line up and there are other important economic factors to deal with, like job growth, but it is encouraging to finally see progress in home prices.

Europe is nearly through its August holiday and the only evidence of progress in the debt crisis has been press releases and sound bites from vacationing heads of state. Recently, however, the German weekly newsmagazine Der Spiegel reported that the European Central Bank (ECB) is once again debating a plan to cap interest rates in countries like Spain and Italy by buying unlimited amounts of their bonds.

The ECB, of course, immediately denied the report, as the plan’s potential to saddle German taxpayers with huge debt makes it a political non-starter for the EU’s most powerful member. Just to underline how Germany doesn’t (at least publically) approve, both the German Finance Ministry and the Bundesbank made it clear that any such plan is unacceptable, which didn’t stop the Spanish and Italian bond markets from rising on the news, thereby lowering interest rates.

Meanwhile, the Eurozone economy, as expected, contracted in the second quarter, with Germany positive, France flat, and most of the remaining countries negative. Less government spending, lack of hiring and worsening consumer sentiment led to a consensus estimate from economists of further contraction in the third quarter followed by weak growth in the fourth.

None of that is good news for the American economy or American investors. Europe as a whole is our largest trading partner, so slack demand across the Atlantic means lowered demand here, slower job growth, and lower profits for many American companies, particularly those with a large percentage of their business overseas. (Think Coca-Cola, Microsoft and General Motors, just to name a few.)

Compounding the problem is the continuing uncertainty as the Euro crisis drags on, month after month, with stalemate, and often economic impotence, built into the structure of the European Union itself. Don’t look for a resolution any time soon.

As always, the best defense is a diversified portfolio and the advice of a smart, experienced financial advisor.

The U.S. stock market, as measured by the S&P 500, has had an outstanding year so far, posting gains of 12.8 percent through August 10. Yet, there are plenty of reasons to feel pessimistic about the future: unemployment is at 8.3 percent, Europe continues to fumble for an answer to its debt crisis, and growth in emerging economies is slowing. How can stocks, which are supposed to trade on future earnings, be doing so well when the financial press is full of caution? We believe the answers to the apparent disconnect lie in the financial reports of U.S. companies for second quarter 2012.

For those watching closely, there has been a lot of good news for stocks. Of the companies in the S&P 500 that have reported second quarter earnings, more than 70 percent have beat Wall Street’s earnings estimates. That means that companies are making more money than analysts expected. As analysts adjust their future estimates to include the recent good news, prices of stocks rise. While earnings are surprising to the upside, revenue—or how much companies sell—has been surprising to the downside. Almost 60 percent of S&P 500 companies missed their Wall Street revenue targets. Companies are making more money than expected, but with fewer sales.

Companies are able to generate more profit per sale by controlling costs. Another way of putting this is that companies are squeezing more and more out of their employees; in economics parlance we call this productivity gains. Productivity gains are good, because it means that each employee produces more, which generally leads to higher wages and more disposable income. Higher disposable income in turn leads to more spending, which leads to higher revenue for companies. You get it—a virtuous cycle of growth. Yet while productivity is rising among those employed, we have a large pool of unemployed workers and that means that wages aren’t rising; try negotiating a raise when there are 3.5 job-seekers for every 1 job opening. Without rising wages, disposable income is stagnant, which means people aren’t buying more things, and that largely explains the missed revenue numbers.

The fact that we haven’t been able to enter the cycle of virtuous growth is part of the reason why the recovery has felt uninspiring. That said, even in this weak environment, companies continue to increase profitability as they squeeze workers for more output without increasing their wages. But, the current state can’t go on forever. Companies will eventually start hiring and that will result in higher wages. Either there will be virtuous growth OR companies will start to put up disappointing earnings. We don’t know which scenario will play out, but we are hoping, along with the rest of the country, for the former.

The jump in volatility recently has caught the interest of many investors and prompted thoughtful questions about the economy. We have been tracking three primary subject areas on a daily basis through these unusual global financial events: (1) the health of the U.S. financial recovery; (2) the European debt crisis; and, to a lesser degree, (3) the health of China and other Asian economies. These first two issues are at the heart of the recent market volatility.

The European Union is in an unfortunate position of slow to declining growth combined with unmanageable levels of debt. In most economic downturns, the cycle to reverse the decline is a decrease in interest rates by the Central Bank, which puts more cash into the system and creates a declining currency value. As a result of low borrowing rates and attractive currency exchange rates, domestic and international spending slowly improves. The 17-member Euro zone does not have this luxury because, while they share a Central Bank lending rate and currency exchange rate, they pay their own sovereign debt at a borrowing rate set by the market. Countries that have very high levels of debt—like Greece, Spain, Ireland, Portugal and Italy—cannot muster the growth needed to raise revenue to pay their existing debt and cannot issue more debt at a cheap enough rate to make it financially viable for the long term. It is a vicious cycle that has been a decade in the making. While it seems to have been a slow-moving train wreck, we appear to be nearing the climax. Ultimately, that should be good news because it would create some clarity in an uncertain world. The hope is that the Euro zone will solve the current problems without an undue level of bank failures and defaulting loans, while also fixing the deficiencies in the system. There have finally been some meaningful ideas offered, such as a rescue fund that can borrow from the European Central Bank, thus ensuring enough resources to bail out even a large participant like Spain.

In addition to news from Europe, every day we see some chart that compares the current financial recovery in the United States to recoveries in the past. More often than not, the current recovery is shown to be very weak and fallible compared to others. A strong recovery creates jobs, increases our standard of living, and ultimately increases personal net worth. We want a strong recovery because we want all of the above, so it is disappointing when jobs growth or retail sales or home sales are reported to be unexpectedly weak. Although it has been frustratingly slow, and may continue to be for awhile, the good news is that our economy is making progress. The even better news is that when the rest of the world gets its act together, the United States seems poised for solid growth and a recovery. Recent earnings reports show a very lean corporate America with little fat to trim. A pickup in global sales should have a pronounced and immediate impact on the American economy.

The outcome of the European debt situation and the recovery path of the U.S. economic recovery will influence the financial models and the psyche of investors worldwide. While the volatility causes us to pay extra close attention to world events, our outlook for a slow and steady recovery in the United States has not changed. We have lived through many of these market “blips” over the past few years and will probably experience many more over time.

Have you read about or heard about the “fiscal cliff” the U.S. is facing? In 2011 an agreement was reached in Congress to raise the amount of debt the government could issue so that the U.S. wouldn’t default on its obligations. There was a catch however, if Congress couldn’t come up with offsetting cuts by the beginning of 2013, $641 billion in spending cuts and tax hikes would automatically go into effect. The impact of these cuts, which are equal to almost 5% of the US Gross Domestic Product (GDP), could be devastating, sending the U.S. back into recession.

At the time these cuts were set in place, 2013 seemed like a long way away and the cuts that were laid out were so draconian, that an agreement seemed all but certain. Now 2013 is approaching, and a solution has not yet been proposed; the impending drastic spending cuts and tax hikes are the fiscal cliff you will be hearing more about in the media in the coming weeks and months.

Wealth Enhancement Group isn’t alone in worrying about the impacts of this fiscal cliff. Chairman Bernanke expressed his concern in a statement during a June meeting before the Joint Economic Committee of the U.S. Congress and said that if Congress failed to address the fiscal cliff, it would “pose a significant threat to the recovery.” Former President Bill Clinton stated that we need to “find some way to avoid the fiscal cliff, to avoid doing anything that would contract the economy now” on a CNBC interview. And, Treasury Secretary Larry Summers added that the top priority should be not taking “gasoline out of the tank at the end of this year.” Federal Reserve Bank of Dallas President Richard Fisher added fuel to the fire, sharing his view that Congress has had “reckless fiscal policy.” Making matters even more complicated, political observers don’t expect any action before the presidential election in November, which provides very limited time to actually address these important budget issues.

So with these spending cuts and tax hikes our politicians have put a trigger in place that could lead to slower growth and even recession. At Wealth Enhancement Group, we have enough faith in the political system of the U.S. that we believe a deal will be reached that will avoid “yanking the rug out” from under what is already a fragile economy.

In the end, politicians are usually rational and if they don’t find a solution, they’ll be responsible for what may clearly be bad decisions and one that won’t help them win votes. The best-case scenario for the economy and markets would be a grand bargain that maintains short-term spending, but reduces the country’s long-term, unfunded liabilities. While a grand bargain may still be out of reach, we believe that smaller compromises are more likely than not. So while we’re concerned about the fiscal cliff, we ultimately think that the worst case scenario is unlikely.